If it’s the American Dream to own a home, going through bankruptcy or foreclosure may very well be the American Nightmare. But if you've filed for bankruptcy or been through a foreclosure at some point, all is not lost. It's still possible to obtain a mortgage in the future if you follow these steps.
- If you've been through bankruptcy or foreclosure, that fact will remain on your credit report for at least seven years.
- By paying bills on time and keeping your credit utilization low, you can begin to rebuild your credit.
- After two or three years, you may be eligible for a new mortgage, but expect to pay a higher interest rate than you would have had to before your financial difficulties.
Keep on Top of Your Credit Report
If you've been through bankruptcy or foreclosure, that will be reflected on your credit report for at least seven years. After that period, it should be deleted automatically. But it's worth checking when the time comes, just in case.
By law, the three major credit bureaus, Equifax, Experian, and TransUnion, must provide you with a free copy of your credit report at least once a year. The official website for that purpose is AnnualCreditReport.com.
There is nothing you can do to erase the record of a bankruptcy or foreclosure ahead of schedule. But if you see any mistakes on your credit report that could be damaging to your credit—such as missed payments that you know you actually made—you should take action right away. Each of the major credit bureaus explains the process for disputing incorrect information on its website.
This is important because your credit report holds the information that is used to compute your credit score. The lower your credit score, the more interest you are likely to have to pay on a mortgage and the more difficulty you may have obtaining one, if you're able to get one at all.
Rebuild Your Credit
Both bankruptcy and foreclosure can do major damage to your credit score, although their effect will recede over time.
In addition to correcting any errors you find on your credit reports, there are some positive steps you can take to increase your score.
For starters, make sure you pay all of your bills on time. Also try to keep your credit utilization ratio low. That's the amount of credit you're using at any given time compared with how much credit you have available to you. For example, if you have maxed out all of your credit cards, you will have a high credit utilization ratio, and your credit score will suffer as a consequence. So try to pay down your debts as soon as possible and, ideally, pay your credit card balances in full every month.
If you don't have a credit card and can't qualify for a regular one, consider applying for a secured credit card. With a secured card, you deposit a sum of money with a bank and that becomes the credit limit on your card. By making small charges to a secured card and paying your bill on time every month, you'll gradually establish better credit, Before too long, you should qualify for a conventional, unsecured credit card. Make sure you make timely payments on that one, too.
Keep Your Job
Even if you're unhappy with your current job, you may want to stick it out for a while if you're trying to get a mortgage. The longer your employment history, the more stable a potential lender will judge you to be. Plus, it suggests that you'll have a reliable source of income for making your mortgage payments.
If it’s been less than two years since your debts were discharged through bankruptcy, you will need to wait to apply for a mortgage. If you lost your previous home to foreclosure, you may have to wait longer, typically at least three years.
If you're applying for a new mortgage after a bankruptcy or foreclosure, expect to make a substantial down payment and pay a higher interest rate.
Prepare to Apply
Once you've established good credit again, and gone through the necessary waiting period, what's next? First, you'll want to make sure you have a substantial down payment saved up—at least 10% or 20% of the price of the home.
Also be sure you know what you're getting yourself into. Because you have come out of bankruptcy or a foreclosure, you will have to pay a higher interest rate on your loan than you would otherwise. That, in turn, will affect how much you can afford to pay for a home. Since you've had problems in the past, you probably don't want to stretch yourself too thin with big mortgage payments, anyway. Here is some guidance from Investopedia on determining how much mortgage you can afford.
The lender may want a co-signer, so keep that in the back of your mind. Check with relatives or friends who may be willing to co-sign the loan for you. Bear in mind that they will be responsible if you can't make the payments —and that could destroy your relationship with them—so do this only as a last resort.
The Bottom Line
A lot of people hit financial rock bottom at some point in their lives and end up with a bankruptcy or foreclosure on their record. If that has happened to you, it doesn't mean you have to give up your dream of owning another home. You may just have to postpone the dream for a bit. Meanwhile, you can use that time to shore up your credit and save up for a down payment.